There is growing investor anxiety about the strength of global equity markets following their strong run in 2013, especially in light of a slightly lackluster economic backdrop. Many equity investors are questioning the efficacy of monetary policy, the level of profit margins and valuations, the threat of Fed tapering and geopolitical risks. Five years after a harrowing economic recession, equity investors still appear largely focused on risk.
Fourth-quarter earnings season announcements are showing stronger signs. Thus far, 68% of companies reporting 4Q 13 earnings beat consensus expectations. Approximately 25% of S&P 500 companies have reported earnings.
Severe weather across much of the U.S. will likely impact economic data in January. Once temperatures return to normal, a bounceback could unfold.
The Federal Open Market Committee announced it will cut its monthly asset purchases by another $10 billion. Despite concerns about emerging markets and a weak December payroll report, the Fed will reduce its purchases to $65 billion per month, and leave the interest rate forward guidance unchanged.
A correction in equities may be under way. A price correction would be natural after the substantial increase in prices over the last few months. Potential areas of concern include the squeeze in China's shadow banking system, increasing currency instability in several emerging-markets countries and a renewed spike in interbank borrowing rates in the eurozone. Nevertheless, none of these issues are likely to significantly unsettle the global economy.
Bear markets have almost always coincided with economic recessions.
Today, the developed world has barely recovered from the 2008 financial crisis, and it is not probable that another recession will emerge soon. If this conclusion is correct, the bull market should remain intact. Investors seem to be more upbeat about the world economy and prospects for stocks than they were 10 months ago, but signs of a bubble are not yet prevalent.
A forward price to earnings (P/E) ratio of 16 for the S&P 500 is not viewed as extreme, compared with a 10-year U.S. Treasury yield of 2.75%. We believe the sweet spot for equities is when the underlying economy remains weak but recovering, and monetary policy is stimulative.
We have been in the sweet spot for some time, and it is likely to continue.
Profit growth is about to accelerate. The eurozone is coming out of a recession and the U.S. economy remains below its potential. Also, inflation rates in G7 countries are below central bank targets. Overbought conditions and periodic worries about the impact of Fed tapering, particularly in emerging markets, is causing near-term choppiness. While the current turmoil may not be over, current conditions do not suggest a sustained decline in equity prices.
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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville. The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.
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